Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.

Monday, 21 December 2015

There’s a phenomenally easy way to eradicate poverty in less developed countries. I deserve a Nobel Prize for thinking of this. I’ll take Pakistan and the UK as examples, and it goes like this.

The entire population of Pakistan moves to the UK. Obviously that couldn’t be done instantaneously, but over five or ten years it could be done. And the entire population of the UK moves to Pakistan.

Since immigrants are amazingly productive (it’s racist to suggest otherwise), the new arrivals in the UK would all have the wages and output per head that are normal for a developed country. Any idea that Pakistanis would bring with them the political corruption and the poor levels of education that currently exist in Pakistan is racist, xenophobic, fascist, Nazi, etc etc. So clearly all the factors that currently explain poverty in Pakistan (genetic and/or cultural) disappear overnight when those migrants arrive in the UK.

As for UK citizens moving to Pakistan, they’d obviously retain the characteristics that make the UK one of the better off countries in the World, so “New Pakistan” (situated to the north of India) would immediately become a fully developed country.

What could possibly be wrong with that idea? What’s wrong will be obvious to tabloid readers, as to whether intellectual leftie broadsheet readers will be able to see what’s wrong, that’s debatable. “Out of the mouths of babes…”, as they say.

Sunday, 20 December 2015

That’s in this article. Essentially the article criticises the concept of debt free money. He says for example “Money is always and everywhere else an IOU”, and IOUs are of course a form of debt.

Another couple of sentences of his along similar lines to the latter quote runs as follows: “Imagine a sovereign that issues “debt-free” coins. They look like normal coins, but when you take them back to the exchequer, your taxes are not paid. The exchequer does not recognize them as a debt—as a promise to redeem yourself in tax payment–but rather as a bit of base metal.”

That’s not a bad point. What Wray is saying is as follows. When the tax authorities demand $X from you, that’s obviously a debt owed by you to government. And it’s widely accepted that one debt can be cancelled out by an equal and opposite debt. So if you give the tax authorities $X worth of $100 bills, then those bills perform the function of an “equal and opposite debt”.

However, in other respects, state issued money is genuinely debt free. To illustrate, Bank of England £10 notes say something like “I, governor of the Bank of England, promise to pay the bearer on demand the sum of £10”. So it seems those notes REALLY ARE a debt owed by the BoE to the holders of £10 notes.

But of course if you turn up at the BoE and demand £10 worth of gold or anything else in return for your £10 note, you’ll be told to shove off. So in that sense, state issued money is NOT A DEBT.

In contrast, debt is very much part and parcel of COMMERCIAL BANK created money. To illustrate, when you get a loan from a bank (perhaps after depositing security / collateral), the bank sets up two equal and opposite debts. First there is a debt owed by the bank to you, commonly known as “money”. And the bank undertakes to transfer that debt to others when instructed by you to do so when you use your cheque book, debit card or whatever. The equal and opposite debt is the undertaking by you to repay that money to the bank at some point in the future.

And just to muddy the picture still further, there is another sense in which money created by commercial banks is NOT a form of debt. I set out the details here.

Conclusion.

The concepts “debt based” and “debt free” money are complicated. There is certainly SOMETHING in the claim that commercial bank issued money is debt based, and in the claim that central bank money is debt free. But there are lots of iffs and buts to be attached to those claims.

Friday, 18 December 2015

By way of celebrating the recent rise in interest rates in the US, let’s run thru the litany of false logic behind interest rate adjustments.

The first problem is that while adjusting demand is an important function of the state, there is no earthly reason to do that by JUST changing borrowing, lending and investment activity. That is, THERE ARE households and firms which DO NOT borrow or lend to any great extent, while there are obviously others which borrow or lend significant amounts. And interest rate changes will influence the behavior of the latter much more than the former. There is no good reason for that distinction.

That is, given inadequate demand, the solution is to raise demand for ALL PRODUCTS or at least for a wide variety of products. I.e. there is more no reason to confine the change in demand to those who borrow heavily, than there is to confined the change in demand to chewing gum, cars, education and lollipops.

The free market’s cure for recessions.

Indeed, that “increased demand for almost all products” is exactly what happens under the free market’s cure for recessions: wages fall, which raises the value of the monetary base and government debt in real terms, which increases the private sector’s assets in real terms, which encourages spending (as pointed out by Krugman). That phenomenon is sometimes called the “Pigou effect” though Krugman doesn’t actually mention Pigou in that article. Obviously the Pigou effect doesn't work too well in the real world, though to judge by the 1800s, the free market does actually cure recessions eventually.

Of course if the change in demand IS NARROWLY focused (as under interest rate cuts), the extra demand will eventually trickle out to the rest of the economy, but that’s still no excuse for the initial narrow focus or distortion of the economy.

In short, when demand is adjusted, it should be adjusted by fiscal means or least to a significant extent by fiscal means because that normally involves stimulus for a broad selection of economic activities. That is, if for example personal taxes are cut, that increases spending by most households. Those in the UK who live just on the state pension would’nt be much affected by that, but their income can be increased by other fiscal measures: e.g. increasing the state pension.

Artificially high interest rates.

A second absurd aspect of interest rate adjustments is that the state has to artificially inflate interest rates if it’s going to go be able to subsequently CUT them.

To explain why, it is first necessary to clarify the distinction between two quite separate functions performed by the state: first, states (i.e. governments) often borrow so as to fund infrastructure and similar invetments, and second, governments borrow SIMPLY to rein in demand and/or raise interest rates.

To keep things simple, let’s assume the state funds infrastructure etc out of tax, or if it does fund them out of borrowing, then relevant bonds are kept separate from “as currency issuer” bonds. I.e. those infrastructure bonds could be issued on the same basis as a private sector firm might issue bonds, with bond holders standing to make a loss if the relevant projects go over-budget (as was the case with the French-English Channel tunnel).

So that’s infrastructure put on one side. Now let’s consider government as currency issuer and interest rates.

The amount of currency (i.e. base money) the state basically needs to issue is whatever amount keeps the economy at capacity. The state can of course issue an excessive amount, and deal with the resultant excess aggregate demand by borrowing some of that money back. But what’s the point of that? All it does is to artificially raise interest rates.

To repeat, in order to use interest rate adjustments to influence demand, governments have to issue an excessive amount of money and borrow some of it back at an artificially inflated rate of interest.

Inequalities.

Even more absurd is that process of issuing an excess amount of money and borrowing some of it back increases inequalities. That is, the less well off have to pay taxes to fund artificially high interest payments to the cash rich.

And alternative way to implement stimulus is for government to borrow and spend the money borrowed (and/or cut taxes). Plus it then has to buy back enough of those bonds to make sure the initial borrowing does not raise interest rates.

Apart from creating work for paper pushers and bankers in the world’s financial centres who take their cut at every turn, that process doesn’t make much sense, particularly given that the effect of borrwing is DEFLATIONARY. What’s the point of doing something that has a DEFLATIONARY element when the object of the exercise is the opposite, namely stimulus? That makes as much sense as throwing dirt over your living room wall before re-decorating it.

In short, why not do what Keynes suggested in the early 1930s, namely just have the state print money when stimulus is needed and spend it, and/or cut taxes. That comes to nearly the same thing as the Pigou effect.

Lags.

Interest rate adjustments might make sense if they worked more QUICKLY that fiscal policy, but all the evidence is that there is not much difference “lag-wise”.

Moreover, there is evidence that interest rate adjustments are not all that effective. As Jamie Galbriath put it, “Firms invest when they can make money, not when interest rates are low”.

And what do you know? The above policy of having government simply create new money and spend it in a recession is what’s advocated by a number of those who back full reserve banking. See here. And that in turn comes to much the same thing as the Pigou effect.

Controlling inflation.

Of course there needs to be tight control of the amount of new money created under the system advocated here. But that’s easily done by having some sort of committee of economists make that decision, like the EXISTING central bank committees that determine interest rate adjustments, QE and so on. Indeed, under the existing system and under the system proposed here, the job of that committee is the same: to determine the amount of stimulus needed.

And finally the above is not to suggest that adjusting interest rates is a tool that should NEVER be used. In an emergency obviously it’s a useful tool. But normally interest rate adjustments don’t make sense.

Thursday, 17 December 2015

In today’s Financial Times he has penned an article in favour of the UK staying in the EU. His first point is that the UK “.. has access to the single market..”.

Er – yes – and if the UK left the EU it would still have access to the “single market”, just like the UK has access to the US market, and all without being in any sort of political union with the US.

Why it’s necessary to make the latter blitheringly obvious point is a mystery.

Soros’s next point is that the recent Paris meeting on global warming illustrated the importance of countries working together on various issues, which somehow proves the need for the UK to stay in the EU. So if the UK was outside the EU, would it be particularly difficult for UK politicians to travel to Paris or any other European capital and take part in international meetings? I mean does the UK leaving the EU mean some sort of Berlin wall is erected in the middle of the English Channel, or what?

Soros’s third point is that Russia has territorial ambitions and the rest of Europe needs to stick together to counter that threat. Well there is an organisation called NATO which Soros evidently hasn’t heard of. And as a result of Poland and other East European countries joining NATO and/or the EU over the last 20 years, the NATO/Russia border is now several hundred miles nearer Moscow than it used to be.

Tuesday, 15 December 2015

Bit of an odd question isn't it? I mean there’s no reason to “fiscally consolidate” (i.e. cut the deficit / run a surplus and pay back government debt) unless the private sector is in exceptionally buoyant mood. Put another way, there is no good reason for the state to implement deflationary measures unless that’s needed to thwart inflation.

In short, the state SHOULD ensure as far as possible that demand stays constant and as high as possible. Or as Keynes put it, “Look after unemployment, and the budget will look after itself”. And assuming it does that, then there’s no reason for households to cut back. So what’s all that stuff in the BoE paper about households cutting back their spending?

Put another way, the only circumstances in which any sane government would go for fiscal consolidation in a big way are circumstances in which that fiscal consolidation would have NO EFFECT on household spending.

At any rate, I was lucky enough to overhear one of the BoE interviewers asking a household (in Bradford) about fiscal consolidation. It went something like this.

Knock at front door. Wife opens door.

Wife, “Hello luv”.

Bank of England interviewer, “Good morning madam. I’d like to ask you about fiscal consolidation.”

Wife, “Yer what pet”.

Interviewer, “Fiscal consolidation”.

Wife to husband who is in kitchen, “Hey Wilf, there’s somebody at t’ front door wants to know about fiscal consolidation”

Simon Wren-Lewis (Oxford economics prof) argues in The Independent that for the first decade or so of the Euro, Germany hammered down costs to an excessive extent and became too competitive. In particular he argues that Germany kept its unit labor costs too low.

Not sure about that.

The target that EZ countries are supposed to aim for is an INFLATION rate of just below 2%. And for the first decade of the Euro, Germany seems to have hit the target near enough, at least according to this source.
Incidentally Bill Mitchell also takes Wren-Lewis to task in a 3,500 word article today. But my 80 or so word criticism above is, needless to say, much more succinct and better value for money..:-)

Monday, 14 December 2015

This Financial Times article repeats the myth that bank capital is expensive. As the author puts it, “New regulations mean all banks must hold more equity, and that means they have to earn higher profits to keep return on equity at the levels investors demand.”

Seems it’s necessary to keep pointing out the fallacy in the latter point, so here goes.

Shareholders only demand a higher return than debt holders (i.e. bondholders and depositors) because shareholders get a hair cut FIRST when problems arise. I.e. it’s only AFTER shareholders have been wiped out that bondholders have a problem.

Ergo if the bank’s capital ratio is say doubled, then the extent of that “first hair cut” problem per share is HALVED. Ergo the return shareholders will demand for undertaking risk is halved. Ergo if the capital ratio is doubled, there shouldn’t be any effect of the total cost of funding the bank.

I get the distinct impression from the above quoted sentence that the author (Laura Noonan) doesn’t get that point, because she talks about “keeping the return on equity at” a particular level.

To illustrate the point another way, suppose there are two banks which are identical except that one is funded entirely or almost entirely by debt, and the other is funded entirely or almost entirely by equity.

The return demanded by both types of bank funder will be the same in that they’re both parting with savings rather than spending those savings. They will also demand a return in respect of risk.

But the risk of the bank going under is the same in both cases given that the riskiness of the banks’ assets is the same in both cases. Thus the chance of shareholders and debt holders being wiped out or losing X% of their money is the same in each case.

So shareholders and bondholders will demand the same return for parting with savings, plus they’ll demand the same for accepting risk.

The only possible escape from the above argument is that bondholders UNDERESTIMATE risk. That is the more naïve bond holders may be under the impression that £X of freshly issued bonds means the bondholder is guaranteed to get £X back when the bonds mature.

That however is not a strong argument for funding banks via debt because it involves taking advantage of peoples’ ignorance or naivity.

As distinct from the latter “naïve” reason for thinking bondholders will get their money back, there is a more sophisticated reason, namely the calculation that governments will not in practice let bondholders be ruined come a bank crisis. That calculation paid off hansomely in the recent crisis. That is, large bondholders are often personal friends of politicians and regulators. And one doesn’t want to ruin people one regularly meets at cocktail parties does one?

The morality of that reason for bonds being a cheap way of funding banks does not stand inspection, of course.

And finally, Google is funded 90% by equity. And as we all know, Google is a total failure. A complete basket case…:-)

Incidentally, I got that information about Google from avideo by Anat Admati.

Saturday, 12 December 2015

Friday, 11 December 2015

John Redwood is often said to one of the Tory Party’s intellectuals. Normally I agree with much of what he has to say. But in the second paragraph of this article he says in reference to helicopter money:

“By this they mean the Central Bank creates new electronic money in an account (the modern version of printing notes or clipping coins) and gives it to people. The idea is they would then go out and spend. The sages think that if the economy is working below full capacity then the extra money spent will be more demand, and will bring more of the unused raw materials and labour into use. Clearly the conditions would have to be very unusual. Normally if a Central Bank prints more and gives it away or spends the cash it leads to more inflation.”

Perhaps John Redwood can then explain to us why we’ve had an enormous increase in government / central bank created money over the last two or three years thanks to QE (both in the UK, US and elsewhere), yet inflation is nowhere in sight!!!!

You might argue that QE has not put money in to the hands of the “people” referred to by Redwood, but rather into the hands of the government bond holders who were bought out thanks to QE. Hence (given that the tendency of the wealthy to increase their spending when their stock of cash rises is more muted than in the case of the less well off) that would explain the relatively muted rise in spending and demand and hence inflation. Unfortunately that argument is weak and for the following reasons.

What happened in the recent “QE years” was that governments boosted fiscal stimulus (i.e borrowed more than usual and gave bonds to those it borrowed from). That will have transferred money from the rich to the less well off. The state (i.e. the government / central bank machine) then printed money and bought back those bonds. Net result: cash in the hands of both the rich and poor will have risen, which comes to the same thing as helicopter drops.

Unusual conditions.

Moreover, what’s all that nonsense in the above quote from Redwood about conditions having to be “very unusual” for increased spending not to cause inflation? The only condition needed is that the economy has significant spare capacity, or put another way that unemployment is above NAIRU: which has been the situation over the last seven years or so.

If a firm gets increased orders for its wares and it advertises for more staff, and suitable applicants are two a penny, then wages in the relevant professions / skills / jobs concerned will not be pushed upwards. In contrast, if there are skill shortages in relevant jobs, then wages WILL TEND to be pushed up. Inflation ensues.

Why I need to spell out this elementary stuff to a supposed intellectual is a mystery.

Are heli-drops desirable?

Having said that, I’m not actually advocating heli-drops (i.e. some sort of system via which every household gets the same amount of cash, or gets an amount inversely related to their income, or whatever). Reason is that heli-drops can be effected via the existing public expenditure system. That is, if you want to feed money into household pockets, why not just cut direct taxes, raise the state pension or something like that? Why set up an entirely new system, staffed by ten thousand bureaucrats to do more or less the same thing?

Thursday, 10 December 2015

I’m thrilled to learn from Ann Pettifor’s letter in the Financial Times today that “investment is not constrained by savings”. So the UK can invest £30bn in the proposed HS2 rail project, and no one needs to save in the form of spending less on beer, home improvements, cars etc to pay for it? This is wondrous news. Instant wealth appears from nowhere.

The relevant paragraph in her letter reads “As Keynes explained and understood, in an economy based on credit, investment is not constrained by savings. Many of those who lay claim to his theories still do not accept this basic principle of a credit-based economy — applied in the UK since the founding of the Bank of England in 1694.”

I’d like to be the first to propose Ms Pettifor is awarded a Nobel Prize for this amazing insight.

Wednesday, 9 December 2015

Working out the exact size of the subsidy or gift that taxpayers were forced to make to banksters is not easy. The following is back of the envelope estimate.

It seems from this source that the total amount loaned by the Fed to banks was $16trillion and the loans were at a zero or near zero rate of interest.

Now what would have been a realistic or appropriate rate of interest? Well Walter Bagehot’s famous answer to that was a “penalty” rate of interest, and in exchange for first class collateral.

One of the reasons for that penalty rate is that a borrower who suddenly finds their cash flow calculations are nonsense, is incompetent. Commercial banks themselves charge penalty rates to borrowers who suddenly claim they need emergency funding, and quite right.

As to exactly what that penalty rate should be, Warren Buffet loaned $5bn to Goldman Sachs at the height of the crisis at 10%. So presumably 10% is a fair “penalty rate”.

So roughly speaking, those Fed loans to banks were at zero percent, when in fact they should have been at 10%.

As to the duration of those loans, I don’t have exact figures, but to keep things simple, let’s say one year. On that basis, banks were subsidised to the extent of $1.6trillion. Or at least they were subsidised to the extent of $1.6trillion PER YEAR for however long the loans lasted.

The money came from thin air?

Several members of the revolving door brigade, with a view to claiming they weren’t subsidised at all, have claimed the Fed created the relevant money out of thin air (which it did), and hence that the whole operation didn’t cost taxpayers anything.

That claim is blatantly dishonest. Reason is that there was an alternative to rescuing banks: the Fed, or more generally “the state” (i.e. central bank and government) could have dealt with the deflationary or recession inducing effects of bank failures by simply dishing out billions to the country’s taxpayers, and citizens generally. And/or the state could have implemented a large rise in public spending (something a left of centre government might have chosen to do).

Now you might claim that largesse towards taxpayer / citizens would have been a subsidy of taxpayers just as much as lending $16trillion to banks at a near zero rate of interest was a subsidy. Well the answer to that is that it’s widely accepted that it is the state’s job to maintain demand at a level that keeps the economy at capacity or “full employment”, whether there’s a bank crisis or not.

Central banks and Treasuries do that ALL THE TIME: i.e. they cut interest rates when appropriate, adjust the size of the deficit and so on. And that activity is not normally regarded as subsidy, and quite right.

Moreover, dishing out money created from thin air to taxpayers during a recession simply immitates the free market’s own cure for recessions (which in practice doesn’t work very well). That is, in a totally free and perfectly functioning market, and given a recession, prices and wages would drop, which in turn would increase the value of the monetary base, which in turn increases the paper assets of the private sector, which in turn induces the private sector to spend more. And that cures the recession. That’s known as the “Pigou effect”.

Of course in the real world, the Pigou effect doesn’t work very quickly because as Keynes famously put it, “wages are sticky downwards”. That is, if you try to cut wages, you often get riots.

In short, if the state dishes out money to taxpayers during a recession (e.g. by cutting taxes), all the state is doing is to IMITATE or bolster the free market’s cure for recessions.

And a subsidy is a payment which does not take place under free market conditions. Thus, in a sense, having the state print and dish out money to taxpayers or citizens in general is not a subsidy.

In contrast, there is absolutely no way that having the state dish out trillions to a very small and select group of firms, banks or any other group, is not a subsidy.

__________

P.S. (11th Dec). David Andolfatto argues here that central banks should not charge penalty rates. In the comments, I stick to my view that the rate should be “penalty”.

Graeber should be congratulated for helping explain how the bank and monetary system really works, which is significantly different from how the proverbial man in the street understands it, and indeed how some economics text books explain it. However the following sentence of his in The Guardian is not correct. (The same error is made incidentally by others)

“What this means is that the real limit on the amount of money in circulation is not how much the central bank is willing to lend, but how much government, firms, and ordinary citizens, are willing to borrow.”

The flaw in that argument is that the total amount of debt VASTLY exceeds the amount of money needed to make the economy work.

To illustrate, in the UK, SME trade debts alone amount to three times GDP, never mind mortgages and debts between large firms, etc. (That probably doubles the "three times" figure).

In contrast, the amount of money needed by the average household is little more than what's needed to tide them over from one monthly pay day to the next. That's roughly one twelfth GDP. But trebble that if you like and make it a quarter of GDP. That quarter of GDP figure is a minute fraction of the above three or six times GDP figure.

That point can be illustrated by reference to King Henry I and tally sticks, which are a form of money. Henry (who came to the throne in 1100) introduced tally sticks to England in a big way (though tally sticks were being used in some sort of fashion throughout Europe long before that).

You could argue that the amount of tally stick money was limited during Henry’s reign by the amount of wood available from which to make those tally sticks. However, that’s not a brilliant argument given that the amount of wood available for tally stick production was probably a good million times the amount actually needed.

Monday, 7 December 2015

James Tobin wrote a work entitled “The Case for Preserving Regulatory Distinctions”. The following is a longish extract.

I believe, therefore, that the monetary and depository system should be restructured to reduce the reliance now placed on deposit insurance to protect the monetary payments system. I have two proposals. One is to provide a kind of deposit money so safe that it does not have to be insured. The second is to make in advance a sharp distinction between insured and uninsured liabilities, and to stick to it. This involves separating "commercial banks," which accept insured deposits, from "investment banks," which do not.

To diminish the reliance of the payments system on deposit insurance, I have proposed making available to the public what I call ' 'deposited currency. " Currency-today virtually exclusively Federal Reserve notes-and coin are the basic money and legal tender of the United States. They are generally acceptable in transactions without question. But they have obvious inconveniences-insecurity against loss or theft, indivisibilties of denomination-that limit their use except in small transactions (or in illegal or tax-evading transactions.) These disadvantages, along with zero nominal interest, lead to the substitution of bank deposits for currency. But deposits suffer from their own insecurity, unless guaranteed by the government; and the guarantees of deposit insurance are subject to the abuses discussed above.

I think the government should make available to the public a medium with the convenience of deposits and the safety of currency, essentially currency on deposit, transferable in any amount by check or other order. This could be done in one or more or the following ways:

(a) The Federal Reserve banks themselves could offer such deposits, a species of "Federal Funds." Presumably they would establish conveniently located agencies in private banks or post offices. The Federal Reserve banks would pay for the services of the agents. Potential agents could bid for the contracts. Transactions between holders of deposited currency accounts, or between them and, directly or indirectly, other Federal Funds accounts would be cleared through the Federal Reserve. Wire transfers, as well as checks, would be possible. Giro-type payment orders to other accounts in the system could be made. Overdrafts would not be allowed. Computer capabilities should soon make it possible to withdraw conventional currency at any office or agency, and even to order payments to third parties by card or telephone. Interest at a rate sufficiently below the rates on Treasury securities to cover costs could be paid, and some costs could be charged to accountholders.

(b) Banks and other depository institutions could offer the same type of account, or indeed be required to do so. The deposited funds would be segregated from the other liabilities of the institution, and invested entirely in eligible assets dedicated solely to those liabilities. These would be Federal Funds or Treasury obligations of no more than three months maturity. As in case (a), interest might be paid on Federal Funds in such segregated portfolios.

Sunday, 6 December 2015

If you lend direct to a corporation, i.e. buy its bonds, there is no taxpayer support for you if it goes wrong, and quite right. In contrast, if you lend to a bank (i.e. make a deposit at a bank) and the bank lends to the same corporation, government guarantees you’ll get your money back.

So if you lend DIRECTLY to a corporation, you’re on your own. But if you lend via a bank, the taxpayer rescues you if it all goes wrong. That is an obvious anomaly. So what’s the explanation?

Well the authorities’ motive for maintaining that anomaly is the idea that “money should be used”. I.e. the idea is that money deposited at banks should as far as possible be put to good use. (See for example the Vickers report, sections 3.20-24) That is, if deposits were not loaned on, that money would stand idle, plus total amounts loaned would decline, which would first, cut demand, and second raise interest rates.

As to the “cut demand” point, that is easily dealt with by raising demand (surprise surprise). That is, for example, the state can simply create new money and spend it, and/or cut taxes, with a view to keeping demand at the full employment level, or NAIRU if you like acronyms.

As to the interest rate rise point, the crucial question there is whether the free market rate of interest is attained under the above “anomalous” regime, or under a regime where money which is supposed to be safe is not loaned on. And the answer is that the free market rate of interest (i.e. the GDP maximising rate) is achieved under a “not loaned on” regime.

Reason is that the only way of making loaned on money is safe is to have the taxpayer stand behind that arrangement, i.e. subsidise the arrangement. And subsidies, unless they are for good social reasons, result in GDP not being maximised.

And finally you may have noticed that the above “idle money should be used” argument is just one of dozens of examples of one of the most common mistakes in economics, namely applying microeconomic rules at the macroeconomic level. That is, it makes sense for a microeconomic entity like a firm or household to put its stock of money to good use as far as possible. But from the point of view of the economy as a whole, that argument doesn’t hold. That is, if a proportion of the population decide to hoard large quantities of money, that matters not one iota: the deflationary effect of that can easily be dealt with by having the state simply create and spend whatever amount of money is needed to keep the economy at capacity.

Friday, 4 December 2015

Warren Mosler says in this Huffington article, “The hard lesson of banking history is that the liability side of banking is not the place for market discipline.” Normally I agree with Warren, but no this occasion.

First he doesn’t tell us what the “hard lessons” are or whereabouts in history those lessons are.

Second, regulating the asset side is complicated: witness Warren’s own list of ideas for regulating the asset side in the above Huffington article. But if you want REAL complexity, look at Dodd-Frank: it consists of about 10,000 pages and counting.

In contrast, regulating the liability side is simple. One popular form of “liability side” regulation is raising bank capital ratios. The rule “Banks shall have a capital ratio of 25%” (as advocated by Anat Admati and Martin Wolf) is simple enough.

And taking that further, the basic rules of full reserve banking (which involves a 100% capital ratio) can be written on the back of an envelope. They are:

1. Entities accepting deposits which are supposed to be totally safe can only lodge that money at the central bank (and/or perhaps invest in government debt).

2. Those funding money lenders must accept the risk involved in doing that (rather than having the taxpayer carry the risk).

3. Money lenders must offer a variety of types of loan that “lender funders” can fund. I.e. savers must have the choice of putting their money into safe mortgages, NINJA mortgages, small firms, etc.

And that’s it.

A third problem with regulating the asset side is that the obvious way to make banks / lenders safer is to make the nature of the loans they make safer, e.g. insist that mortgagors have some minimum equity stake in their houses.

But doing that rules out risky loans, and some risky loans turn out to be winners: they’re the basis for starting up businesses which subsequently prosper.

So…. why not allow lenders make any loans they want, as long as those funding those loans carry any loss (rather than taxpayers carrying the loss), and as long as lenders are open and honest with funders as to what’s involved?

And what do you know? The above sort of “regulate the liability” side is what’s involved in full reserve banking, at least as per Lawrence Kotlikoff and Positive Money.

Thursday, 3 December 2015

Krugman considers the free market’s cure for recessions, and points to the fact that in a recession, prices would fall, which would raise the real value of money, which in turn would increase the paper assets of the population, which in turn would encourage spending. That’s known as the Pigou effect (though Krugman doesn’t mention Pigou). As Krugman puts it:

“How is the self-correction of an economy to its long-run equilibrium supposed to work? In textbook analysis, the story is that falling prices raise the real money supply, pushing down interest rates, and hence restoring employment.”

Note that BASE MONEY is the all important form of money here because base money is a net asset as far as the private sector is concerned. In contrast, commercial bank created money nets to nothing because for every dollar or pound of such money, there is a dollar or pound of debt. Thus commercial bank created money is not a net asset as far as the private sector is concerned.

Krugman however doesn’t mention Say’s law, which is another mechanism that tends to bring full employment (though like the Pigou effect it doubtless doesn’t work all that well). Say’s law works even in a barter or non-money economy. I set out a full explanation here.

At least I take it the latter exposition of mine is how Say’s law works. Maybe I’ve thought up an entirely new mechanism that enables the free market to bring full employment, in which case I’d like a Nobel Prize please.

Tuesday, 1 December 2015

Summary. Conventional banks combine two activities, lending and accepting deposits. That combination is essentially fraudulent. The harmful effects of that fraud are remedied to some extent by deposit insurance and lender of last resort. However no public purpose is served by those forms of state assistance to money lenders any more than offering that form of assistance to non-bank corporations would serve public purpose or bring social benefits. Ergo those two activities, lending and accepting deposits, should be separated.

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Private banks have always liked to merge the above two activities, that is, have the same institutions (private banks) perform both functions. Reason is that that “merge” enables private banks to engage in “borrow short and lend long” (i.e. maturity transformation). And that’s profitable.

Unfortunately the above merge is risky. As Adam Levitin (professor of banking law) put it in the first sentence of the abstract of this paper: “Banking is based on two fundamentally irreconcilable functions: safekeeping of deposits and re-lending of deposits.”

The irreconcilability or fraud consists of the fact that banks promise depositors they’ll get their money back at the same time as putting that money at risk by lending it on. That tactic is bound to fail at some point, and when it does depositors are fleeced big time, as happened in the 1930s. Or if government run deposit insurance is in place, which it wasn’t in the 1930s, then it’s still someone other than the miscreant bank who pays, which is nice for the miscreant bank and those funding it. A second form of protection offered by governments / central banks for the above merged system is lender of last resort (LLR).

So there are two possible bank systems. First, a system under which entities which accept deposits lend on those deposits. In view of the risks involved there, taxpayers have to stand behind private banks. Second, there is a system which solves the above problems by having the state only guarantee money lodged with the state. As to lending, that is funded by people who specifically choose to have their money loaned on, and who buy shares or similar stakes in money lenders, and those shares are of course not the same thing as deposits.

A “merge” system protected by deposit insurance and LLR might seem to make sense. In fact it’s a system riddled with flaws, as follows and numbered.

1. The system involves moral hazard: the temptation to take excess risk, keep profits when that works and send the bill to the insurer when it doesn’t. Indeed, it was precisely that that contributed to a significant extent to the crisis in 2007/8.

2. One common excuse for having the state insure money lenders and those who fund them (cited for example by the UK’s Vickers commission) is that doing so encourages loans and investment. Unfortunately exactly the same argument applies to every other industry and those funding them. That is, the latter “encourages investment” argument could equally well be applied to all stock exchange quoted shares and corporate bonds.

Of course there’s no harm in letting those who buy stakes in money lenders or any other industry insure themselves against loss, and a certain amount of that type of insurance takes place. However, to justify the state getting involved in that insurance, there must be some very clear social benefit or public purpose served.

3. The idea that governments or regulators are actually able to work out likely risks and charge an appropriate insurance premium is a joke in view of 2007 crisis.

4. Banks are bound to lobby politicians for an unrealistically low insurance premium.

5. When there are bankruptcies in any industry, it is positively HEALTHY for those who funded the industry to lose out. Bankruptcies tend to indicate the industry is too large, and that resources should be diverted to other activities. Thus far from any public purpose being served by deposit insurance, harm is actually done: that is, the effect is to recompense those who fund money lending, which encourages them to engage in more money lending, or “debt creation”.

I.e. when the FDIC reimburses depositors in a failed bank, depositors put the money in another bank. Failing to deal with malinvestments is a misallocation of resources: it reduces GDP.

It could of course be argued that if state sponsored deposit insurance does harm or reduces GDP, then the same applies to the private insurance (mentioned above) that is sometimes taken out for stakes in industries other than banking. That argument is not totally invalid: that is, possibly the latter form of insurance should be banned.

On the other hand, private insurance is not as “sure” as state sponsored insurance in that private insurers can go bust. I.e. private insurance is in a sense not insurance. Also it’s a generally accepted principle that people should be allowed to do whatever they want (e.g. insure their own legs) unless some very clear harm comes what they do.

So it’s debatable as to whether private insurance of investments like stock exchange quoted shares should be allowed or not.

6. Where money lenders are funded by shares, the entire system is more robust. As the former governor of the Bank of England, Mervyn King put it: “..we saw in 1987 and again in the early 2000s, that a sharp fall in equity values did not cause the same damage as did the banking crisis. Equity markets provide a natural safety valve, and when they suffer sharp falls, economic policy can respond. But when the banking system failed in September 2008, not even massive injections of both liquidity and capital by the state could prevent a devastating collapse of confidence and output around the world.”

In short, banks funded by equity are more resilient than where they are funded by debt (e.g. deposits).

7. Bank regulators the world over have expressed approval of the principle that banks should be treated like any other industry: i.e. that ideally governments should openly declare that no form of assistance will be offered to banks in trouble. Of course what regulators and politicians say in private is very different. As John Kay put it, "With crass hypocrisy, political leaders have set their public faces against future bank rescues while their operatives have reassured markets that they do not mean what they say."

But assuming a government does openly and explicitly declare that there will be no assistance for failing money lenders, then the stakes in those lenders (deposits in particular) ipso facto become shares or bonds or something of the sort: so those stakeholders stand to lose money, whereas depositors are guaranteed not to lose out.

8. Another point which casts doubt on any idea that any public purpose is served by having the state insure those with stakes in money lenders (or any other industry) is the fact that there is a nonsense at the root of that type of insurance, as follows.

The only reason that those who fund money lenders (or any moderately risky industry) get a larger return than is obtainable from near risk free loans, is that more risk is involved. Now if the risk consists for example of a one in X chance of losing all your money in any one year, then the appropriate annual insurance premium would be 1/X of the sum insured. But that wipes out the profit derived from taking the extra risk (never mind the fact that the insurer will want some sort of profit on turnover and capital employed).
In short, insuring those who fund money lenders is as daft as insuring your own legs: to repeat, it probably doesn’t do any harm to let people take out daft forms of insurance, but there certainly isn't any public purpose or social benefit to be had from insuring those who fund money lenders or other industries.

9. In addition to deposit insurance, another form of assistance for private banks is LLR. The rate charged for LLR loans are supposed to be the “penalty” rates suggested by Walter Bagehot. In practice, and thanks to political pressures and bribes payed by bankers to politicians, those rates are nearer zero than “penalty”: a form of subsidy for banks.

10. Contrary to popular belief, Bagehot did not advocate LLR: in the final chapter of his book “Lombard Street” he simply said he thought LLR was so entrenched that it would be very difficult to remove.

11. It is often argued that if the PROPORTION of funding for money lenders that comes from shares is sufficiently high (i.e. if bank capital ratios are high enough), that solves the problem: that is, the chance of depositors losing out can be reduced to a vanishing small level. Thus there is no need for 100% of those who fund money lending to be exposed to risk, i.e. depositors can still to some extent fund money lending.

A problem with that argument is that if those depositors are in fact totally safe at say a 30% capital ratio, then they’d also be totally safe of the rules of the game were changed and their stakes in money lenders became say preference shares. And in that case, those shareholders would charge the same for funding the bank as those former depositors (because the charge made by funders is related to risk, and the risk in both cases is the same). Thus if bank capital ratios are raised to whatever level makes banks totally safe (say 30%), then the cost of funding banks will not rise any further if the ratio is raised to 100%.

Arguments against separation.

The main argument put against separating lending from deposit accepting (put for example by the UK’s Independent Commission on Banking) is that the result would be large amounts of money not being used: effectively, if you like, money sitting in metaphorical safe deposit boxes. The result, allegedly, would be a fall in demand and rise in unemployment.

The answer to that is that the deflationary effect of the separation can easily be countered by standard stimulatory measures, e.g. simply having the state print money and spend it (and/or cut taxes). Thus there is no reason for separation to increase unemployment.

Interest rates.

Another poor argument put against separation is that it would raise interest rates which allegedly would reduce investment and cut economic growth.

The answer to that is that as is widely accepted in economics, GDP is maximised where there is an absence of subsidies, except where there is a clear social case for a subsidy, as is doubtless the case with for example kid’s education. Or in more general terms, there is a case for subsidies and taxes where those subsidies put right an instance of market failure. (Taxes are imposed for example on alcohol because it is thought, rightly no doubt, that social harm derives from excess alcohol consumption.)

However, the onus is on those advocating subsidies and taxes to prove the existence of social benefits, market failure and so on. To repeat, the general and widely accepted rule is that GDP is maximised where market prices prevail, i.e. where there is an absence of subsidies or taxes.

In short the free market rate of interest is probably somewhat higher than the currently prevailing rate, thus moving to that higher rate ought to increase GDP, not reduce it, as claimed by the ICB and others.

Non-peer reviewed (or only lightly peer reviewed) publications. The coloured clickable links below are EITHER the title of the work, OR a very short summary (where I think a short summary conveys more than the title).

i) The above is not a complete list in that earlier versions of some papers have been omitted. For a more complete list see here, and “browse by author” (top of left hand column).

ii) 7 deals with a wide range of alleged reasons for government borrowing, including Keynsian borrow and spend. 6 is an updated version of the "anti-Keynes" arguments in 7. 5 is an updated version of 1, which in turn is an updated version of 4.

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Bits and bobs.

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The Swiss Sovereign Money movement.

The bank subsidy no one mentions.

I can see the point of making accounts at a country’s central bank available to all, and in having that run on block chain / crypto lines (if that’s the most efficient way of operating those accounts). Accounts with the central bank / government have essentially been available to Brits for decades in the form of accounts at National Savings and Investments. Block chain / crypto could make that more efficient.But what’s the point of an OFFICIAL crypto currency where the units are liable to quaduple in value (like Bitcoin) and then crash?

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Study puts the value of the Too Big To Fail subsidy for large Canadian banks at around $1.6billion a year for each bank. And what do the regulators and their cronies in the bank industry do? Mumble into their beards, look the other way, and try to sweep the whole thing under the carpet. (hat tip to Stephanie Schulte)________

The first two sentences of Simon Wren-Lewis’s latest article (15th March) made me laugh:

"I was not going to write anything about the non-event of Hammond’s Spring statement, in part because I confess I am tired of writing about the Conservative party’s hopeless macroeconomic policy. It is like being forced to second mark all the fails from a first year economics exam."________

Larry Kudlow is Trump’s new economic advisor. In Dec. 2007 just before the worst recession since the Great Depression, Kudlow said: “There’s no recession coming. The pessimistas were wrong. It’s not going to happen...The Bush boom is alive and well.” Well that bodes well doesn’t it?

But all is not lost. Cheer up! Trump normally sacks those he has appointed a month after appointing them.....:-) ________

Simon Wren-Lewis (Oxford economics prof) does another article in which he expresses interest in MMT.________

It is precisely the fact that private banks are allowed to create or print money that causes bank failures.

Money is a short term liability of a bank. So if banks can create money, they can engage in “borrow short and lend long”, which is what causes bank failures. But that risky method of money creation is totally unnecessary because central banks can supply the economy with whatever amount of money is needed to bring full employment, and all without the above attendant risk.________

Mark Carney, governor of the Bank of England is not impressed by crypto currencies.________

The Fed implemented QE, which is supposed to have a stimulatory effect, at the same time as paying interest on reserves, which has the opposite effect, i.e. a deflationary effect. Unless I’m much mistaken, that equals schizophrenia.________

Nice article in the Financial Times today entitled “George Osborne austerity target is hit…”. The FT seems enthusiastic about the “austerity target” having been hit. I quite agree. I’m looking forward to women being sent down coal mines, young boys being sent up chimneys to clean them, and the re-introduction of Victorian slums (ho ho).

More seriously, the article shows no understanding of Keynes's point that the deficit / surplus needs to be whatever brings full employment without too much inflation. I.e. deficits are not inherently undesirable, and (contrary to the FT's suggestions) surpluses are not inherently desirable._________

Long time ago, oil companies knew that global warming would change the climate, and adjusted the design of their oil rigs and pipe-lines to suit. They then denied the existence of global warming. Don’t you just love it?________

Wall Street crooks manage to roll back stricter regulation and return to the good old "heads we win, tails the taxpayer loses" arrangement. Meanwhile politicians are way too dumb to know what's going on, and anyway their pockets will have been stuffed with wads of dollar bills to make sure they “see sense”.________

Total fines and out of court settlements paid by US banks (since the 2007 crisis I assume) now stands at $243bn.________

Laugh of the day: Mark Carney tells bankers they should not aim to earn loads of money but should aim to “promote……prosperity in the wider society”. ________

Sarah Bedford of the New Economics Foundation claims output of immigrants in the UK is £17million per day. Least that’s what she SEEMS to be saying: it’s not actually 100% clear what she's saying. Anyway assuming my interpretation of her work is right then…. let’s import the entire population of China: then the "output of immigrants" would be a HUNDRED TIMES more!!!!________

I do like Stephanie Kelton’s MMT colouring book. Filling in the colours should be a compulsory for all those with mental ages below three - i.e. all those under three, and all politicians over the age of three -….:-)________

90% of Euro banknotes issued in Germany are never spent: they’re just hoarded!!!!________

Thinking aloud….free banking (advocated by George Selgin and others) comes to the same thing as full reserve banking, seems to me. Reason is that under free banking there is no deposit insurance, thus deposits at banks are essentially equity: so called “depositors” stand to lose their shirts just like shareholders. At the same time, under free banking, depositors who want total safety are presumably free to deposit money at state run savings banks like National Savings and Investments in the UK. And that is effectively full reserve banking: loans are funded via equity, while no risks whatever are taken with deposits that are supposed to be totally safe.________

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MUSGRAVE'S LAW SOLVES THE FOLLOWING PROBLEM.

The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A and B. Or for more deflation while buying back, apply more of B relative to A